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ECON 308: Employment Decisions

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1 ECON 308: Employment Decisions
Chapter 14 Attracting and Retaining Qualified Employees Chapter 16 Individual Performance Evaluation Week 14: Nov. 30 , 2012

2 Attracting & Retaining Employees
Principles: Maximum Value: Marginal Revenue Product (willing to pay) People won’t come to your firm until you make them at least as well of as the could be elsewhere (Opportunity Cost: Have to pay) Paying more than is needed to attract employees puts a firm at a competitive disadvantage It is in the interest of both employee and firm to maximized the value created in the relationship

3 Chapter 14 Organization No-frills Competitive Labor Market
Some complications Human Capital Compensating Differentials Costly Information Internal Labor Markets The Salary-Fringe Benefit Mix

4 No-Frills Competitive Model
Labor market is competitive no discretion over wages Market Wages are costless to observe Workers are identical Jobs are identical All labor is rented on the spot market All compensation is monetary

5 Basic Competitive Model
Wage in $ Market Wage Rate Marginal Revenue Product of labor E E* Number of Employees

6 Human Capital Terminology Human Capital: Skills
Investment in Human Capital: Education, OJT “rate of return” on Human Capital: MB > MC Types of Human Capital General (Excel, Word, text messaging) Firm Specific: (proprietary software)

7 Compensating Differentials
Consider 3 Welding jobs Job X pays $8/hour in clean, air-conditioned safe working conditions, Job Y pays $8/hour in a dirty, outdoor construction site, Job Z pays $8/hour in ship construction yard. Is this an equilibrium wage?

8 Compensating Differentials
Must pay more when a job has undesirable characteristics $ more must by paid for every 1/10,000 increase in the probability of being killed on the job A firm with 1,000 employees could reduce wages by $20,000-$300,000 per year by preventing one accidental death every 10 years. Knowledge of necessary CD  how to invest in alternatives: safety devices

9 Compensating Differentials
Implications Unpleasant jobs get done Companies are rewarded for making jobs more pleasant Workers may choose the level of risk they wish to face

10 Compensation Information: Costly to acquire
Compensation may be hard to see Workers differ in human capital so they may differ in the compensation offered Firms don’t share all of the details of compensation with prospective employees Symptoms… …of over-paying: too many qualified applicants …of under-paying: few applicants, high turnover

11 Problems with under-paying
Low compensation is associated with high turnover so costs of re-training are high When turnover is high there may be incentive problems

12 Internal Labor Markets
Hire at entry level, promote from within Law Firms, Accounting Firms, Hospitals In 1991 an employee between 45 & 54 had typically been with the same employer for 10 years or longer Half of all men and ¼ of women stay with the same firm at least 20 years Most Internal Labor Markets rely on implicit contracts

13 Tradeoffs in Long-Term Employee Agreements
Benefits of internal labor markets Accumulates more firm-specific human capital Better motivation There is incentive to avoid behavior that is dysfunctional in the long run Managers know more about employee attributes Costs of internal labor markets Restricted competition for advanced jobs

14 Pay in Internal Labor Markets
Compensation Salary Marginal Revenue Product of Labor Tenure with the firm

15 Tradeoffs with Career Earnings
Advantages Efficiency wages reduce turnover and shirking Since pay rises faster than MRPL employees have strong incentives to make the firm look good Promotions become a reward for good behavior Disadvantages Promotions may be manipulated because of destructive behavior toward other rivals Promotions are a crude incentive tool since they are infrequent The Peter Principle: People rise to level of incompetence Much time may be spent lobbying managers for promotions

16 The Salary-Fringe Benefit Mix
Fringe Benefits account for about 25% of compensation for the average American Examples Health Insurance Non-Social Security pension programs Subsidized Education Discounted Meals

17 Indifference Curves Between Salaries and Fringe Benefits
Monetary Compensation Utility = U2 Utility = U1 Fringe Benefits

18 Iso-Cost Lines Between Salaries and Fringe Benefits
$50 K Iso-cost line at $50,000 ($50K) of total payment Monetary Compensation Slope = -1 $50K Fringe Benefits

19 Optimal combination: Salaries and Fringe Benefits
$50 K Monetary Compensation $30K $20K $50K Fringe Benefits

20 Fringe Benefits Payroll taxes Make the iso-cost line flatter
The total tax-bill (including the part paid by the employees) will matter in determining the optimal mix of fringe benefits Applications Fringe benefits can be used to screen for particular types of employees Cafeteria-style plans are desirable when administration costs are low and when adverse selection is not a problem.

21 Chapter 16: Individual Performance Evaluation
ECON 308 Chapter 16: Individual Performance Evaluation Week 14

22 Performance Evaluation
Evaluations provide employees feedback on achievement and ways to improve Evaluations are used to determine rewards and sanctions Performance evaluation entail evaluating employees as well as subunit of the firm 16-22

23 Implicit Assumptions Principal knows agent’s production function
Output is single quantitative measure of performance Output can be observed at zero cost Employee cannot game the measure Employee produces a single output Mutually beneficial contract is feasible Employee works independently 16-23

24 Setting Performance Benchmarks
Time and motion studies Engineers estimate the amount of time a task requires Determines most effective work method Past performance and ratchet effect Employees have incentives to only meet the goal and not exceed it 16-24

25 Measurement Costs Accounting system may need to be developed
Information systems improved Value-maximizing firm improves measures as long as incremental benefits justify costs 16-25

26 Opportunism Gaming Horizon problem
Employees may engage in dysfunctional activities to improve their evaluations Horizon problem Short-run objective performance measure may cause employees to focus on results that influence their evaluation only over their remaining time with the firm 16-26

27 Relative Performance Evaluation
Evaluate worker output relative to their co-workers in the same job Within the firm jobs not always identical group has incentive to punish “rate busters” incentive to hire less competent workers Across firms data hard to obtain 16-27

28 Subjective Performance Evaluation
Firms often use subjective evaluation along with objective measures Multiple tasks and unbalanced effort Workers have incentives to concentrate on activities that are easily measured The subjective measure will allow the supervisor to determine cooperation and other difficult to measure activities 16-28

29 Subjective Evaluation Methods
Standard rating scales Rank employees on various performance factors Goal-based systems Set annual goals and then measure whether the employee achieved them Frequency Often more frequent reviews are too costly May be beneficial with new hires 16-29

30 Problems with Subjective Evaluations
Supervisor shirking Forced distribution May result in good employees being evaluated poorly Influence costs Reneging 16-30

31 Combining Performance Measures
Few job performance measures are purely objective or subjective Both types can be inaccurate increasing inaccuracy of either places greater weight on other inaccuracies increase employee risk Both can induce dysfunctional behaviors 16-31

32 Comparing Individual and Team Output
Q Conrad and Dina’s team output Sum of Conrad’s and Dina’s individual outputs Expected output 25 e 2.5 Conrad’s and Dina’s individual effort levels 16-32

33 Government Regulation of Labor Markets
Anti-discrimination regulations dictate clear performance evaluation systems May be inconsistent with value maximization 16-33

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